In Snap’s I.P.O., Evidence of Bankers’ Strategy

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CreditHarry Campbell

By Steven Davidoff Solomon

March 1, 2017

Snap’s bankers deserve more than the commissions they will receive for a successful, perhaps flawless, initial public offering.

The offering priced on Wednesday at $17 a share, more than the earlier expected range of $14 to $16. That will value the company at nearly $24 billion and make the company’s founders, Bobby Murphy and Evan Spiegel, worth more than $3 billion each.

Not bad for a pair of twentysomethings. (Yes, be jealous — what did you do in the first half of your 20s besides drink beer?)

The key to a successful I.P.O., after all, is to get that first-day pop, as Facebook learned to its chagrin in 2012. And Snap’s shares will most likely rise on Thursday even after exceeding the previous range.

Snap’s bankers accomplished this by underestimating the range from the get-go to build this upward momentum in pricing. There was also careful timing. As a chart being passed around the internet shows, Snap’s daily active user growth may be set to plummet next year, according to Aegis Capital research. The offering was timed not just to be the internet I.P.O. of the year but to capture what may be Snap’s peak growth numbers.

The bankers played another tried-and-true trick: limit the supply. Only about 19 percent of Snap’s total share float was offered, and a quarter of that amount was sold subject to a one-year lockup. Snap’s remaining capital needs were filled by a $1.2 billion loan from the same bankers underwriting the offering.

Snap also orchestrated a very well played public relations game about the company and Mr. Spiegel, its chief executive, portraying him as a once-in-a-generation “visionary.”

Finally, Snap played off the simple laws of supply and demand and the strange world of internet valuations. There are only a few big internet companies around, and when one goes public, investors pounce.

Here, internet valuation does not depend upon silly things like revenue or, heaven forbid, earnings, but prospects. One way (and there are many ways) to think about this, is the chance that Snap has to hit a certain valuation reflected as follows:

Basically, Column 1 is the chance of meeting the valuation in Row 2. You can then value this chance by multiplying column 1 by row 2. So if Snap has a 1 percent chance of reaching a valuation of $100 billion, the value of that chance is $1 billion.

That is the price a rational investor with a taste for risk would pay for that chance. Someone without a taste for risk would prefer paying for a 99 percent chance of getting $1 billion which would be valued at $1.01 billion.

In this chart, the valuation of Snap is $22.8 billion if you add up the value of all the chances. But the chance of Snap being worth below its pricing valuation of $24 billion is 64 percent.

Yet if you are basing this on the prospect of Snap, the valuation set on Wednesday for Snap is a rational bet for a risk taker. You can play with the numbers, but you get the idea that the bigger company you think this might be, the more it adds to the current, risky valuation.

And Snap is all about prospects and risk. It will depend on doing something no other social network has done — which is to invent another product equally successful.

So far, Snap has done only ephemeral pictures well. There is yet to be a verdict on its Spectacles, though they will probably go the way of Google Glass, a brief novelty.

The bet in Snap as it exists today is in preserving and growing the core business, which already may be plateauing, and finding a new business. Can that happen? The chance of it achieving that is how the valuation works.

In this regard, Snap is not Facebook or Twitter, the two most used comparisons. Facebook’s core business was growing at the time of its I.P.O. and has continued to grow since, while Twitter was valued by investors based on what they thought about growth in its main business.

For Snap, investors have ignored some big warning signs. In addition to the possibility of declining user growth, there is also the inability of Snap to gain traction outside the United States or outside its core young demographic. And that Instagram and WhatsApp (under the Facebook umbrella) are emerging as real competitors.

Then there is the governance issue. The company has chosen to keep all control with its co-founders and gives no vote to the shares held by the public. So in some ways, Snap is more like Shake Shack or Fairway with a touch of Theranos, than it is like Facebook or Twitter.

I could, of course, be all wrong about this. There is a chance that Snap will be the next Facebook, churning out products the teenage set loves for the next nine decades of Mr. Spiegel’s life. In a year or two, we should have a good sense of Snap’s direction, and when we do it will be a test not just of the internet I.P.O. model but corporate governance as well.

In the meantime, Snap will likely spur more internet market debuts — after all, there is a drought of them — as bankers sell this good result to push clients out.

And that is really what the Snap offering is about: good deal-making and salesmanship by its bankers at Morgan Stanley and Goldman Sachs.

Congratulations, of a sorts, are due.

Steven Davidoff Solomon is a professor of law at the University of California, Berkeley. His columns can be found at nytimes.com/dealbook. Follow @stevendavidoff on Twitter.